Macro Tsimmis

intelligently hedged investment

BUY Market Vectors Gold Miners ETF (GDX)

Posted by intelledgement on Thu, 07 Apr 11

We have been long gold via the SPDR Gold ETF (GLD) for all but a few months since the inception of the portfolio in January 2007. We believe the prices of commodities in general and gold in particular are headed north as the effect of the massive government spending inevitably leads to inflation and perhaps even risks the integrity of the dollar.

The price of gold has not moved much so far in 2011, even as other commodity prices have continued to surge. We expect this interregnum to end soon, and therefore consider this a relatively good time to buy gold. But as we already own GLD, we have decided to increase our exposure here by going long on the Market Vectors Gold Miners ETF (GDX).

In theory, as the price of gold climbs—all things being equal—the rising profits of gold miners can afford one a better return on investment than owning gold. This is because given a fixed cost to get an ounce of gold out of the ground, the profit margin of a mining company is “leveraged.” Let’s say gold is going for $1000/ounce and it costs a mining company $900 to produce that ounce of gold. They are making a profit of $100 on every ounce. Now if you buy gold here, and the price goes to $1100, you have a profit of 10%. But if you buy the mining company instead, their profits are up from $100/ounce  to $200/ounce—a 100% increase. Their stock probably won’t double, but it is likely to go up considerably more than 10%.

Of course, all things are not equal. For one thing, mining is a capricious activity, fraught with risks—accidents, bad exploration results, the country you’re operating in has an unstable government, your ore is of poorer quality than expected and requires expensive and technically difficult processing, etcetera, etcetera. For another thing, all things are not equal—in an inflationary environment, your costs of production are going to rise, too, cutting into that leverage effect.

However, we believe that as the dollar, the euro, and the yen become shakier, the relative demand for gold as a safe storehouse of value will increase and thus the price rise will outstrip the pace of inflation…and consequently, gold mining companies in general should prosper. And of course the way to avoid the risks attendant to any particular miner is to spread that risk over many miners…which brings us to GDX.

This fund has been around for nearly five years, and is up 70% in that time (compounded annual growth rate of 12%) compared to +6% for the S&P 500 (CAGR of +1%). It is liquid, with over nine million shares traded each day on average, and a market cap of $6.9B. The Gold Miners ETF seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the NYSE Arca Gold Miners Index. The Index provides exposure to publicly traded companies worldwide involved primarily in the mining for gold, representing a diversified blend of small-, mid- and large-capitalization stocks. For more info, including details on expenses, dividend and price history, performance versus the index, and holdings of the fund, check out Van Eck Global’s website.


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